Why do Investors Update Reference Prices Asymmetrically?

Abstract

One of the most pervasive financial decisions that consumers engage in is the purchase and sale of common stock. The goal of this research is to understand the conditions under which consumers update the reference prices of their investments, which influence stock-trading decisions. Four studies show that individual investors not only update reference prices to a greater extent when their stock breaks even after following a positive path (i.e. values above purchase price) versus a negative path (i.e., values below purchase price), but this asymmetry in reference-price updating (Studies 1-2) can be accounted for by investors’ tendency to view price increases as a relevant basis for short-term action (e.g., taking profits); price decreases elicit little motivation for short-term action. Giving investors a short-term outlook increases reference-price updating (Study 3). The authors find that memory for positive extrema is more accurate than for negative extrema, which suggests greater attention to positive-path prices, thus supporting the proposed view (Study 4). These findings have implications for explaining individual investors’ tendency to remain invested amid significant stock market losses.